The FY10 Budget: Highlights and Assessment. Summary

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized The FY10 Budget: Highlights and Assessment Summary The Finance Minister presented a budget on June 11, 2009 that contains many sound expenditure proposals and some innovative ideas, and is appropriately expansionary in intent. However, the government will be hard-pressed to meet its goals for raising revenue or carry out its ambitious expenditure plans, especially in the key Annual Development Program (ADP). The budget also partially halts the progress in trade liberalization of recent years and increases protection of already over-protected domestic industries. The budget reduces non-merit subsidies, expands protection for the poor and vulnerable, prioritizes rural development and seeks to redress regional disparities. It provides for infrastructure development beyond the traditional ADP, and maintains a provision to deal with the possible impact of the global recession. Subsidies and transfers are decreased to 3.7 percent of GDP from 4.2 percent in the FY09 revised budget. Existing safety net programs are strengthened and some new programs introduced. Total allocation to the social safety net and social empowerment programs rise by 25.2 percent. The share of cash-based programs in total safety nets is also increased, which could help to improve their overall effectiveness. The proposed Tk 305 billion 1 ADP gives priority to rural development, fuel and energy sectors and transportation. It also aims to redress regional disparities and appears to place strong emphasis on project completion. For the first time, the FY10 budget introduces the concept of public private partnerships as a vehicle for infrastructure investment, and allocates Tk. 25 billion to such projects. There is also a Tk 50 billion provision for a fiscal stimulus and other measures to lessen the impact of the global recession. The programs initiated under the FY09 fiscal stimulus package will continue and be expanded if necessary. The expansionary fiscal stance of the budget is appropriate, given that growth is subject to significant downside risks, but its effectiveness will depend on the quality and quantity of actual spending. The budget provides for public expenditures to increase if, for example, exports and remittance growth slow further and liquidity in the banking system tightens. In such circumstances, an expansionary fiscal stance aimed at increasing productive assets and protecting the vulnerable can be helpful. However, weak implementation capacity could undermine the extent to which additional development expenditures are realized. The ambitious spending plans depend on the government s ability to mobilize concessional external financing and strengthen the revenue intake. The budget could fail to meet its expansionary targets if spending is hobbled by weak implementation capacity, as in the past. In any case, a more effective way to contain deficits would be to improve the state s ability to raise revenues and stem losses from state-owned enterprises. This would also improve the effectiveness of public expenditure. In addition to the risk of the budget undershooting its deficit target, the cost of financing the deficit may remain high if the ADP falls short of its targets because this would reduce the availability of 1 US$ Taka (July 9, 2009) 1

2 low-interest external financing. The projected amount of net external financing required for FY10 (2 percent of GDP) is high to begin with. A shortfall in external financing may force the government to turn to bank or even monetary financing of the deficit, which could fuel inflationary pressures and crowd out credit in the private sector. The revenue growth target is challenging; Bangladesh has one of the lowest revenue/gdp ratios in the world. Historically, revenue collection has grown by one or two percentage points, at most, above the nominal GDP growth rate. Since expected growth of total revenue for FY10 is 3.2 percentage points higher than the projected nominal GDP growth rate, the administration will be hard-pressed to achieve its target. The steady progress made in trade liberalization in recent years is partially reversed, in a country that already has high rates of protection. The average nominal protection in FY10 is increased to 22.9 percent from 20.1 percent in FY09, mainly because of a wider imposition of para-tariffs and the introduction of a 5 percent regulatory duty. Even though customs duty is reduced on 965 tariff lines in FY10, the benefits are offset by the wider application of a supplementary duty, imposed on 144 additional tariff lines, and a regulatory duty, imposed on 2,683 tariff lines. Effective protection, especially for domestic industry, is also expected to increase in FY10 due to the scaling down of customs duty on raw materials and retention of the duty rate on finished goods. These measures favor domestic industry at the expense of the consumer, and could lead to an increase in consumer prices. Civil society and trade bodies have applauded such protectionism, on the grounds that it increases domestic demand at a time when external demand for Bangladeshi products is weakening. However, this static view of protection neglects the negative impact on exporters, consumers and the long-term competitiveness of Bangladeshi firms. 2

3 The FY10 Budget: Highlights and Assessment I. The Context Bangladesh produced its FY10 budget in a time of political change, as the national leadership was successfully transforming from an unelected, caretaker authority into a fully democratic government with a strong majority. The budget was a defining moment for the new ruling party alliance to make good on its electoral promises to: Maintain economic stability and growth in the face of a deep and protracted global recession; Address a challenging power and energy deficit; Alleviate poverty by raising agricultural production and stimulating the rural economy, and; Root out corruption and improve governance. Political Economy Pressures: Being the first budget of the new government, it carried more significance than those of previous years. The promises contained in the ruling Awami League s election manifesto raised expectations of a budget to benefit everyone. Several stakeholders tried to bend the budget along populist lines, pointing to the election manifesto and the ongoing global economic downturn. Public opinion favored an expansionary and protectionist budget: cutting or eliminating taxes on raw materials and intermediate goods while increasing or at best maintaining levies on finished products, particularly on luxury items. Demands for reducing corporate taxes and continuing the tax holiday facility were popular. The Awami League s manifesto promised a comprehensive long-term policy on electricity and energy, increased support for agriculture and the rural economy and expansion of safety nets. The trade bodies and think-tanks were also unanimous in demanding greater allocation for power and energy. They suggested establishment of funds to redress the power, infrastructure, and energy deficits. The Awami League s manifesto also called for policies to avert the negative impact of a global economic meltdown. Commercial stakeholders, particularly exporters, demanded various forms of policy support for their sectors: for instance, an export stabilization fund or financial crisis mitigation fund to protect exporters and for rehabilitation and skills development of returnee-expatriates and unemployed people, and lowinterest loans for the affected and vulnerable sectors, returnee migrants and retrenched workers. Recent Economic Performance: The Bangladesh economy remained resilient to external adversities in FY09, with some help from nature. Major agricultural recovery from the damages caused by floods, a cyclone and avian flu the year before; sustained export growth; a surge in remittance inflows, and a steady flow of private sector credit, helped achieve an estimated 5.9 percent growth in FY09, compared with 6.2 percent in FY08. So far, the global recession has affected Bangladesh mainly through declining non-garment exports, slower growth in manpower exports, and some slackening in investment momentum, reflected in weak growth of capital machinery imports. Bangladesh has also benefitted from the global recession through a decrease in import prices - particularly food, fertilizer and fuel which have helped reduce inflation to a projected 7 percent in FY09, compared with 9.9 percent in FY08. However, the decline in year-on-year inflation, particularly since October 2008, appears to have Figure 1: Real GDP Growth (%) FY90 FY92 FY94 FY96 FY98 FY00 FY02 FY04 Source: Bangladesh Bureau of Statistics FY06 FY08 3

4 bottomed out with inflation rising to 5.4 percent in April 2009 compared with 5 percent in March. Nonfood inflation increased gradually from 4.8 percent in December 2008 to 6.5 percent in April. Figure 2: Inflation (%) Figure 3: Foreign Exchange Reserves (Million US$) FY96 FY98 FY00 FY02 FY04 FY06 FY08 General Food Non-Food FY02:Q2 FY03:Q1 FY03:Q4 FY04:Q3 FY05:Q2 FY06:Q1 FY06:Q4 FY07:Q3 FY08:Q2 FY09:Q1 FY09:Q4 Source: Bangladesh Bureau of Statistics Source: Bangladesh Bank The external current account has a surplus of over US$1 billion in the first three quarters of FY09, the foreign exchange reserve crossed US$7 billion in mid-june 2009 and the Bangladesh Bank has bought US$1.04 billion (so far in FY09) from the foreign exchange market (US$181 million in May alone) to keep the exchange rate stable at around Tk 69/US$. Commercial banks are awash with excess liquidity (Tk 237 bilion at the end of March 2009 compared with Tk 130 billion at end June 2008) following a 10 percent decline in demand for industrial term lending in the first three quarters of FY09. Growth of credit to the private sector has slowed from 25.7 percent in July 2008 to 17 percent in March While FY09 export and remittance growth have so far remained strong, the emerging trends are worrisome. Overall exports earnings for FY09 (July-Apr) reached US$12.8 billion compared to US$11.4 billion during the same period last year, registering 12.8 percent growth. However, the overall export growth rate hides the diverging performance of the readymade garment (RMG) and non-rmg sector. The total value of RMG exports amounted to US$10.1 billion during July-April, which corresponds to a cumulative growth of 18.1 percent compared to the same period last year. Earnings from non-rmg products declined in FY09 (July-April) by 3.8 percent. Overall export performance has weakened since the beginning of calendar year Export growth rates Figure 4: Monthly Export Growth (%) have declined significantly during February-April 2009 when overall exports grew by 1.3 percent and 70 RMG by 6.8 percent. Earnings from non-rmg 60 declined by15.8 percent during this period. Also, the 50 RMG sector expects some slowdown in the near future: both Bangladesh Garment Manufacturers and 20 Exporters Association and Bangladesh Knitwear 10 Manufacturers and Exporters Association have been 0-10 reporting declining export orders since the beginning of Given the time lag between orders and shipment of 4 months for woven garments and 3 Source: Export Promotion Bureau months for knitwear, the trade bodies feel that RMG export growth could be flat or even negative in the coming months. Apart from declining demand, RMG producers are also reporting falling prices, by around 15 percent. The exporters association does not expect the situation to improve until Q2 of FY10. Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 4

5 The remittance outlook is also becoming less positive. Figure 5: Monthly Remittances Growth (%) Remittance inflow and overseas employment have been resilient to the global economic downturn in the first 11 months of FY09, with remittances reaching 60 US$8.8 billion. This corresponds to a 22.4 percent increase relative to the same period last year. During 30 this period, 611,000 migrant workers found 20 employment abroad compared to 871,000 in the same 10 0 period last year, registering a 30 percent decline. With a slowdown in growth of monthly remittance inflow, sharp decline in outflow of migrant workers and increase in the number of return migrants during January-May 2009, recent trends look worrisome. Source: Bangladesh Bank Growth in monthly remittance earning continued to slow from 21 percent to 8 percent during January April 2009 before rebounding to 22 percent growth in May During January-May 2009, the outflow of workers was 212,000 compared to 378,000 during the same period last year a 44 percent decline. During January-May 2009 approximately 40,000 migrant workers have reportedly returned to Bangladesh. Since most of the remittance earners are unskilled or low skilled workers from the rural areas, any adverse impact on remittance inflows and employment of Bangladeshis abroad would endanger the livelihoods of many poor and vulnerable households in both rural and urban areas. Medium-Term Economic Outlook and Fiscal Strategy: The adverse developments in the global economy have increased uncertainty about the medium-term economic forecasts. The FY10 budget is predicated on the assumption that economic growth will slow further to 5.5 percent in FY10 before picking up in subsequent years as the global economy recovers. Inflation in FY10 is projected to decline to 6.5 percent with international commodity prices remaining depressed and continued increases in domestic food production. With slower growth in exports and remittances, the external current account balance is projected to deteriorate somewhat over the medium term and the level of foreign exchange reserves to decline from the current 3-months equivalent of import cover to 2.8-months by FY12. The government s fiscal policy in recent years has been based around a deficit target of 4 percent of GDP. 2 The government has been able to meet this target despite undershooting revenue targets, and expenditure pressures arising from natural calamities and political developments. Due to the anticipated impact of the global recession on inflation and growth of GDP, imports, remittances, and export, the medium-term revenue targets have been revised downwards relative to the trajectory projected when preparing the FY09 budget. The revenue forecasts are highly sensitive to changes in the key macroeconomic variables. 3 Demands for subsidies and, therefore, higher expenditures have eased slightly because of declining commodity prices. The Medium-Term (FY10-12) Budget Framework anchoring the FY10 Budget assumes that the risk of this being reversed during the next two years is low. 4 The government s fiscal strategy for this period emphasizes maintaining macroeconomic stability and fiscal sustainability while investing in infrastructure and human development in order to reinvigorate economic growth. It also emphasizes maintaining the flexibility to introduce additional fiscal measures in the event that the global crisis has a more adverse impact on Bangladesh than currently anticipated. Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 2 Finance Division, Ministry of Finance, Medium-Term Budget Framework 2009/ /12, Chapter-1, 3 For instance, a one percent variation in GDP growth is estimated to give rise to 1.4 percent variation in tax revenues. A further concern is the potential impact of slower remittance growth on import demand and hence import based tax revenues. 4 MTBF document, p

6 II. Overall Budget Deficit, Financing and Public Debt The overall budget deficit is projected to increase from 4.1 percent of GDP in the FY09 revised budget to 5 percent in FY10 and remain close to this level in the subsequent two years (Table-1). The government s strategy has been to cover as much deficit as possible from external grants and concessional credits. However, external financing has been declining in recent years with the exception of FY08 when external financing increased due to emergency assistance to cope with the impact of natural disasters. External financing is projected to increase to 2 percent of GDP in FY10, compared with an estimated 1.8 percent in the FY09 revised budget. Gross disbursement of external assistance has averaged US$1.5 billion per annum in the current decade. Given this historical record along with the tight international financial conditions, the absence of a substantial structural reform program so far, and the prospect of some regressive amendments to Public Procurement Act and Public Procurement Regulation, this expectation appears to be unrealistic. 5 Figure 6: Govt. Revenue & Expenditure (% of GDP) Figure 7: Budget Deficit & Deficit Financing (% of GDP) Total Expenditure Total Revenue Net foreign financing FY90 FY93 FY96 FY99 FY02 FY05 FY08 Net domestic financing Budget deficit FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 (B) Source: Ministry of Finance Source: Ministry of Finance The decline in concessional external financing relative to GDP combined with an increase in budget deficit in recent years has led to greater reliance on (higher cost) domestic borrowing. Domestic borrowing is projected at 3 percent of GDP in FY10, compared with 2.3 percent in the revised FY09 budget, and relying largely on borrowing from the banking system. Total cost of borrowing has thus increased significantly. While the cost of government borrowing both as a share of total debt and as a share of GDP is low compared to many other countries, interest costs as a share of total expenditure are much greater due to the relatively low levels of total revenue and total spending. Bangladesh s current and projected levels of public debt remain sustainable, although interest rates are on the rise. Notwithstanding the rise in the deficit, total outstanding public debt has been declining in recent years and this is projected to continue. Total debt-to-gdp has declined from 49.6 percent in FY07 to 44.8 percent in FY09 and is projected to decline to 43.6 percent in FY10 and further to 42.8 percent by FY12 with domestic debt-to-gdp stabilizing at 21.3 percent. External debt still accounts for 55 percent of total debt, despite a significant increase in the share of domestic debt in total debt, from 39 percent in FY07 to 45 percent in FY09. Since external debt is mostly concessional, it has a relatively lower impact on debt repayments. Amortization and interest payments on external debt declined from 5.4 percent of exports of goods and services in FY07 to 4.6 percent in FY09 and are projected to decline to 3.3 percent by FY12. The effective interest rate on external debt has declined from 1.1 percent in FY06 to 1 percent in FY09, but that on domestic debt has increased from 9 percent in FY06 to 9.7 percent in FY09. 5 Foreign aid declined sharply to US$453 million in the second half of FY09, compared with US$1.03 billion in the first half. This was due to substantial cuts in aid by major bilateral donors. 6

7 Consequently, the effective interest rate on total debt has increased from 4 percent in FY06 to 4.8 percent in FY09. The deficit of state-owned enterprises (SOEs) decreased in FY09. Overall net losses of non-financial SOEs declined to Tk 1.5 billion in FY09, compared with Tk 99.9 billion losses in FY08. This largely reflects a decline of the Bangladesh Petroleum Corporation s (BPC) s losses from Tk 95.5 billion in FY08 to Tk 35.8 billion in FY09 as a result of both increased pass-through of import parity prices of petroleum products to domestic prices as well as a decline in import parity prices themselves. A second reason was the performance of the Bangladesh Telephone Regulatory Commission which made a profit of Tk 32.4 billion in FY09, compared with Tk 0.4 billion losses in FY08. However, the losses of the Bangladesh Power Development Board increased from Tk 9.9 billion in FY08 to Tk 15.7 billion in FY09. Contingent liabilities have declined as well. The current stock of contingent liabilities is estimated at Tk 99.3 billion, equivalent to 1.6 percent of GDP. This is about 41.2 percent lower than government s contingent liability from last year, mainly because of a significant decline in losses from oil trading by the BPC. Nearly 60 percent of the government s current contingent liability is on account of the Bangladesh Krishi Bank and Rajshahi Krishi Unnayan Bank, which specialize in lending to the agriculture sector. Table 1: The Budget Deficit and its Financing Percent of GDP FY07 FY08 FY09 FY10 FY11 FY12 Actual Actual Revised Budget Projection Projection Primary Deficit Interest Total Financing External Financing Loans Grants Amortization Domestic Financing Borrowing from the Banking System o/w Bangladesh Bank Other Banks Non-bank Borrowing Total central government debt/gdp (percent) Source: ERD, Bangladesh Bank Using standard debt sustainability assumptions, it can be shown that the projected level of primary deficit is sustainable if GDP growth is 5.5 percent or higher and the nominal effective interest rate is 9 percent or lower. 6 The ability to mobilize concessional foreign financing will therefore be critical. If foreign financing continues to decline, Bangladesh may face a sustained rise in the effective interest rate because 6 Sustainability is defined as the primary balance required to keep the debt-gdp ratio constant at the current 44.8 percent. 7

8 of increases in costly domestic debt, thus requiring a substantially smaller primary deficit or even a surplus in the medium-term. III. Risks to Debt Sustainability As can be expected, the public debt position is vulnerable to a growth slowdown. According to the joint Bank-Fund Debt Sustainability Analysis completed in September 2008, 7 the net present value (NPV) of the public debt-to-gdp ratio ceases to decline when growth slows down to baseline minus one-half the standard deviation of the historical growth rate (about 5.6 percent per year). In fact, because the low growth scenario also assumes that revenues adjust downward to lower growth whereas expenditures do not, the debt-to-gdp ratio starts to rise modestly in the outer years (2015 onwards). This highlights the need to manage expenditures prudently, while protecting priority spending, in the event of a growth slowdown. Public debt indicators are also vulnerable to one-off debt creating flows. Under-pricing of energy products by BPC and Bangladesh Power Development Board, and of fertilizer prices by Bangladesh Chemical Industries Corporation have created contingent liabilities that may need to be borne by the government. Until last year, these contingent liabilities grew by almost 1 percent of GDP per annum. The decrease in contingent liabilities in FY09 was largely due to fortuitous circumstances and, therefore, cannot be taken for granted. In the absence of an effective strategy to address this problem, the risks of large debt-creating flows in the future remain. Under the assumption of a one-off debt creating flow of 10 percent of GDP which could be conservative given that contingent liabilities will increase again when international commodity prices rebound unless policies are changed the debt-service-to-revenue ratio reaches 36 percent in 2010, compared with the baseline ratio of 23 percent. The government has made significant progress in improving Bangladesh s medium-term debt strategy formulation. A committee has been created under the chairmanship of the Resource and Debt Management Wing of the Finance Division of the Ministry of Finance with members from all the divisions and departments that currently deal with debt information; UNCTAD s debt management system (DMFAS) was installed to help to monitor and analyze existing debt; and Finance Division staff are working with Fund and Bank staff to familiarize themselves with the preparation of DSAs. It will be important to build on these steps and move forward quickly to strengthen debt management capacity, starting from the development of a comprehensive external and domestic debt data base and to centralize the reporting of all external aid and domestic debt flows. IV. Level and Composition of Expenditures Public expenditure in recent years has increased from 13.3 percent of GDP in FY04 to 15.3 percent in FY09. The increases were driven by rise in subsidies and transfers from 2.4 percent of GDP in FY04 to 4.2 percent, mostly on account of increases in export, agriculture and food subsidies. The budget also took on board the losses incurred by BPC, BCIC and BPDB because of lack of pass-through of increases in international prices of crude oil and petroleum products, fertilizer and unit costs of power production to domestic prices. A second feature of recent public expenditure trends is the secular decline in ADP spending. The FY10 budget has surpassed the size of all previous budgets in Bangladesh s history. Total expenditure is projected to grow by 20.9 percent from Tk billion (15.3 percent of GDP) in the FY09 revised budget to Tk 1,138.2 billion (16.6 percent of GDP) in the FY10 budget. About 61 percent of the FY10 budget comprises of recurrent expenditures, the same proportion as in the original FY09 budget. The government s Medium Term Budget Framework identifies energy and power, social safety 7 Bangladesh: Joint Fund-World Bank Debt Sustainability Analysis (DSA) 2008, September 2,

9 nets, education and health as top priorities. In addition, a number of spending initiatives that have been funded in the FY10 budget will affect expenditure allocations in FY10-12: fiscal stimulus package (Tk 50 billion), public-private partnership (Tk 25 billion), implementation of Pay Commission recommendations (Tk 35 billion), implementation of an urgent three-year program to increase electricity generation (Tk 35.7 billion), and construction of a 6 km bridge across the Padma river (Tk 15 billion). Current Expenditure: The current expenditure in the FY09 revised budget has increased to 10.2 percent of GDP, compared with 9.5 percent in FY08. The current expenditure in FY10 budget has increased by 10.9 percent. Pay and allowances have increased by 8.8 billion or 5.8 percent. This increment, however, is regular and does not cover the resources required to implement Pay Commission recommendations. The Pay Commission s recommendations are currently under consideration and the government intends to implement them in phases from July A Tk 35 billion block allocation has been made and included in the Finance Division budget to implement the final agreed pay increase. Once a decision is made, this block allocation will be distributed to the different ministries and divisions. Allocation for repairs, maintenance and rehabilitation is reduced to Tk billion in FY10 budget, compared with Tk 25.6 billion in the FY09 revised budget. The reduction in allocation to O&M even in nominal terms is a cause for concern. Subsidies and transfers have decreased from 4.2 percent of GDP in the FY09 revised budget to 3.7 percent in FY10 budget. Subsidy to agriculture (fertilizer and other agricultural inputs) is reduced from Tk billion in the FY09 revised budget to Tk. 36 billion in the FY10 budget, reflecting the decline in international prices of agricultural inputs. Considering low oil prices, there is no direct provision for a petroleum subsidy in FY10 budget, but Tk 14 billion from the block allocation can be utilized as subsidy if needed. The budget also has provisions for a power subsidy (Tk 12 billion), export subsidy (Tk 18 billion), and food subsidy (Tk 12.3 billion). Overall, subsidies in the FY10 budget have declined by 16.5 percent while transfers have increased by 7.1 percent. Safety Net Programs: The existing safety net programs have been strengthened while a few new programs have been introduced as promised in the Awami League s election manifesto (Box II). At present, 6.9 million families (22.8 percent of the total population and 60 percent of poor) are included in existing social safety net programs and the government plans to bring another 3.5 million families (11.6 percent of total population and 30 percent of poor) under safety nets in the medium term. Total allocation to the social safety net and social empowerment programs has increased by 25.2 percent, from Tk 138 billion (2.3 percent of GDP) in FY09 revised budget to Tk 173 billion (2.5 percent of GDP) in FY10 budget. The share of cash-based programs in total safety nets allocation has increased from 61.8 percent to 66.1 percent while share of food-based programs has declined from 38.2 percent to 33.9 percent. Cashbased programs as percent of GDP have increased from 1.4 to 1.7 while food-based programs as percent of GDP have remained same at 0.9. Allocation to Food for Work (FFW) has declined by 9.2 percent, and from 0.2 percent of GDP in FY09 to 0.1 percent of GDP in FY10. Among other social expenditures, safety nets for the poor, aged and distressed cover provision of social services, housing, rehabilitation and training; ensuring food security; providing relief and rehabilitation to natural disaster victims, and employment generation. Funding is also provided to support women-focused micro-credit programs. Finally, Tk billion has been allocated for Employment Generation for the Hard Core Poor program, a variation of last year s 100 Days Employment Generation Scheme. While this employment scheme for the poorest of the poor will be started in the August-October period, the coverage of the program has not yet been finalized. Stimulus Package: There is also a Tk 50 billion provision in the budget for providing fiscal stimulus in response to the global recession. The FY10 budget speech does not provide any additional details of the government s stimulus package, but merely reiterates that the programs initiated in FY09 under the fiscal 9

10 stimulus package will continue (Box I) and be expanded if necessary. The measures initiated in FY09 include subsidies to export industries, steps for expanding the labor market abroad, speeding up implementation of the ADP, boosting investment through recapitalization of some state-owned banks, and accelerating activities under different funds supervised by the Bangladesh Bank. In addition to the measures already initiated, the government promises a series of austerity measures to reduce public expenditure. Development Expenditure: The government has proposed a Tk 305 billion ADP for FY10. This is a 32.6 percent increase over the FY09 revised ADP. When considered in the context of the annual nominal growth of revised ADP during last decade at a rate of 5.8 percent per annum, the proposed increase in the FY10 ADP is ambitious. 8 The shares of internal and external resources in the proposed ADP are 44 and 56 percent respectively. To implement the proposed ADP, the internal and external resources have to grow by 41.2 and 26 percent respectively relative to the FY09-revised ADP. The same growth rates during the last 10 years were just 6.3 and 5.5 percent respectively. In addition to the ADP, government has also allocated Tk 11.4 billion to non-adp Food for Work (FFW), Tk 14.2 billion for development programs financed from the revenue budget and Tk 12.3 billion for projects outside ADP. Thus the proposed total development expenditure in the budget is Tk billon, compared with Tk billion in the FY09 revised budget an ambitious 34 percent increase. 9 Emphasis on project completion appears to have increased. The total number of investment projects included in the proposed ADP is 664, compared with 677 investment projects in the FY09 original ADP. Of the total number of projects, 647 are carried over from FY09 and 17 are new. Such a shift favoring the completion of the ongoing projects rather than undertaking new ones is a welcome move. No allocation has been made to 107 unapproved projects in the FY10 ADP. However, Tk billion has been set aside for these projects, subject to approval. The FY10 ADP gives priority to rural development, fuel and energy, and transportation. It also aims to redress regional disparities. Local government and rural development received the highest allocation, Tk billion, which is percent of the total ADP. The total allocation for agriculture is Tk billion (Tk billion from the ADP and 0.24 from non-adp Food For Work & Transfer) which accounts for 7.79 per cent of the ADP. Fuel and Energy are allocated Tk billion percent of the total ADP. Transport and communication sectors receive Tk billion, equal to 15.7 percent of the ADP. Education and Health jointly receive percent of the ADP. An additional allocation has been made to projects in Rajshahi, Khulna and Barisal divisions to redress regional disparities Figure 8: Original ADP Allocation (Billion Taka) and Utilization (% of Original Allocation) FY77 FY80 FY83 FY86 FY89 FY92 FY95 FY98 FY01 FY04 FY07 Original Allocation (left axis) ADP Utilization (right axis) Source: Planning Commission and Implementation, Monitoring, & Evaluation Division (IMED) Note also that actual ADP utilization rate was 81 percent of original ADP during FY00-09 and 76 percent during FY Development expenditure in FY09 revised budget is 87 percent of the original budget on account of underutilization of every singly line item. 10

11 The ADP implementation has never exceeded the Tk 200 billion mark to date. The utilization rate has tended to decline as the original ADP size grew bigger and bigger (Figure 8). The Finance Minister outlined some measures in his budget speech to improve the implementation of the ADP. These included strengthening monitoring in 10 ministries responsible for 78 percent of the ADP, formulating advance procurement planning, simplification of the project approval process, and using the Critical Path Method to monitor some of the major projects. PPP Budget: For the first time, the FY10 budget formally introduces the concept of public private partnerships (PPPs) as a vehicle for infrastructure investment. The move to leverage private sector resources for investment in infrastructure arises from the government s desire to boost investment as a critical vehicle for attaining its growth target of 8 percent by 2013 and 10 percent The rationale for formalizing PPP initiatives includes: Government alone cannot provide for the additional investment of US$28 billion, the estimated amount of investment required by FY14 to attain the growth target; The private sector can share the risk while government can complement funds to ensure commercial viability, and; Economic use of resources will be ensured and service delivery will be of better quality. The budget provides for three components to facilitate projects under the PPP provision. The components are: o o o US$14.5 million (Tk 1.0 billion) for PPP technical assistance (TA) fund US$43.5 million (Tk 3.0 billion) as Viability Gap funding to attract private initiatives US$305 million (Tk 21.0 billion) for setting up an Infrastructure Investment Fund (IIF) to be used as equity or loan support to the private investors. Creation of the Infrastructure Investment Facility, along with a PPP TA fund and viability gap fund is a good starting point to combine the strengths of the public and private sectors. Private investors from Bangladesh as well as overseas will factor this into their investment plan. However, the success of this effort will depend to a large extent on transparent sector regulation and the independence of the regulator, as well as clarity on risk sharing between the government and private sector. It will also require effective execution and administration of the IIF fund. The executing agency for IIF will need to be careful to ensure that only bona fide and competent private entrepreneurs can access the fund. Also important is the question of monitoring and supervision of PPP projects, as the implementation gets going. A lot of care and judgment should be applied while setting up the PPP management authority. The following are some of the guiding principles in this respect: (i) The success of the PPP program is dependent on political will and, equally important, on the quality of human and other resources dedicated to the PPP cell; (ii) At the sector level, a transparent and sound regulatory regime, including independent regulation, fair tariffs, etc., are preconditions for interest in PPP projects among reputable investors. (iii) The sharing of risk between the private and public sectors is a major issue in PPP projects. This needs to be addressed clearly and transparently. Failure to do so could lead to major contingent liabilities for the government. (iv) PPP units with executive power and independence tend to be more effective than those that are purely advisory. It is important that the power be coupled with a mandate to promote and facilitate good PPPs. 11

12 (v) Ineffective governments tend to have ineffective PPP units. Where government agencies have weak governance, PPP units tend to suffer the same fate. (vi) Effective PPP units have mostly been attached to Ministries of Finance. This reflects the natural role of the ministry in coordinating government policies and expenditure, its mandate to manage fiscal risk, and the financial power it derives from managing public finance. V. Revenue Mobilization The FY10 revenue target is set at Tk billion. Total revenue is projected to grow by 14.9 percent in FY10 relative to the FY09 revised revenue target, leading to a modest increase in the revenue/gdp ratio from 11.2 percent in FY09 to 11.6 percent in FY10. Tax revenue is projected to grow by 15.2 percent and non-tax revenue by 13.6 percent. National Board of Revenue (NBR) taxes, which account for over 95 percent of total tax collections, are projected to grow by 13.6 percent. The increase in the tax/gdp ratio from 9.0 percent in FY09 to 9.3 percent in FY10 is projected to come entirely from growth in NBR tax revenues, particularly income tax and VAT. The former is projected to grow at 22.3 percent and the latter at 13.3 percent. Growth in import duty is expected to be a more modest 9 percent. Income taxes (29.4 percent), VAT (26.1 percent) and supplementary duties (13.3 percent) are projected to be the largest contributors to the increase in total revenue. The revenue growth target is challenging. The projected 11.7 percent nominal GDP growth for FY10 provides a benchmark to assess the feasibility of the government s revenue projection. Historically, revenue collection has managed to grow at least as fast as the nominal GDP growth rate plus one or two percentage points at times. Since expected growth of total revenue for FY10 is 3.2 percentage points higher than the projected nominal GDP growth rate, its attainment seems ambitious. Similarly, projected growth of NBR revenue collection is 1.9 percentage points higher than the nominal GDP growth rate. Achieving the projected NBR revenue target will require an extra tax effort yielding an additional 1-2 percentage points in tax revenue growth. In FY09, NBR revenue was projected to increase by 18.6 percent in the original budget, but has been reduced to 15.3 percent in the revised budget. However, the actual outturn is unlikely to exceed percent, as NBR revenue collection in FY09 slowed considerably compared to FY08. Growth was only 12.7 percent during the first 10 months of FY09, compared to 23.7 percent for the same period in FY08. The government has announced several measures to boost income tax collection. Among them is a proposal to create a money whitening facility (that allows investment of undisclosed money in certain new industries or physical infrastructure or the share market). The proposed amendment in the Income- Tax Ordinance in this regard states: 10 no question as to the source of any sum invested by any person in a new industry or physical infrastructure facility during the period between the first day of July 2009 and the thirtieth day of June 2010 (both days inclusive) shall be raised if the assessee pays, before the filing of return for the relevant income year, tax at the rate of ten percent on such sum (Box III). Similarly, it allows investment of undisclosed money in the share market, balancing, modernization, renovation and extension of an existing industry; in real estate by paying a tax at a specific rate according to the measurement of the flat/house; and in the purchase of stocks and shares. 11 Corporate income tax rate on financial institutions was reduced from 45 percent to 42.5 percent before the budget was passed by the parliament on June Finance Bill , Chapter The money whitening scheme could have an unintended effect of reducing individual income tax collection during next two years. Any individual who is in a 10-plus percent income tax bracket now has an incentive to not disclose income till 2012 to take advantage of this scheme in

13 Other measures to boost income tax include setting up a National Tax Tribunal, surveys in a number of upazilas to widen the income tax base and identify new tax payers, and expanding the Income Tax Department. Existing tax holidays will remain in force until 2012, but will not be extended any further. They will be replaced with provisions for payment of taxes at a reduced rate. Measures that will reduce the income tax bill include lowering the age bar from 70 years to 65 years, which will reduce the taxes paid by senior citizens; and reduction in the corporate tax rate for mobile phone operators to 35 percent. The government intends to strengthen collection of VAT by broadening the tax base and phasing out existing exemptions. Among the services that no longer benefit from VAT exemptions are travel agencies and manpower exporter organizations. In addition, the FY10 budget proposes to expand the VAT departments by creating: (i) (ii) (iii) (iv) a VAT Divisional Office in each district and necessary circle offices; three new VAT Commissionerates in greater Dhaka and Chittagong; A new VAT Survey Directorate, and; increased manpower, logistics and transport for various field offices of VAT. Other measures include an increase in the rate of Advance Trade VAT from 1.5 percent to 2.25 percent. Although the government s growth projection for import duty is rather modest, a higher than anticipated reduction in the value of import-based taxes poses downside risks to the FY10 revenue target. While Bangladesh has been largely unaffected by the first-round effects stemming from the global economic crisis, declining import demand and falling international prices have already started to reduce the relative share of import-based taxes in overall revenue collection. In the first ten months of FY09, the share of import-based taxes declined to 41.7 percent from 42.8 percent in the corresponding period of FY08. Hence the government s emphasis on collecting higher revenue from domestic sources is welcome. It intends to augment revenue collection through broadening the tax base, establishing transparency and accountability in tax management, and increasing efficiency in tax administration. In addition, the government emphasizes the importance of bringing income, corporate tax and VAT under complete automation process. Changes in Import Tariff Structure VI. Trade Policy The steady progress made in trade liberalization in the past few years by gradually scaling down nominal protection is reversed in the FY10 budget. The average nominal protection in FY10 rises to 22.9 Figure 9: FY00 FY10: Overall Avg Nominal Protection(%) & Avg Nominal Protection on Final consumer goods percent, from 20.1 percent in FY09 because of wider imposition of para-tariffs and the introduction of a 5 50 percent regulatory duty. In the FY10 budget, even 40 Overall Avg though customs duty is reduced on 965 tariff lines, it 30 Nominal Protection(%) is offset by the wider application of supplementary 20 duty (imposed on 144 additional tariff lines) and 10 regulatory duty (imposed on 2683 tariff lines). FY10 continues to implement a four-tier customs duty structure. Customs duty on basic raw materials is lowered to 5 percent from 7 percent while customs duty on capital goods, intermediate FY00 FY01 FY02 FY03 FY04 Source: Tariff database FY05 FY06 FY07 FY08 Avg Nominal Protection on Final consumer goods(%) FY09 FY10 13

14 products and finished goods remains unchanged at 3 percent, 12 percent and 25 percent respectively. The number of supplementary duty slabs increases to seven (20, 30, 45, 60, 100, 250 & 350 percents) from the existing five (20, 60, 100, 250 & 350 percents) and a 5 percent regulatory duty is introduced. All supplementary duties and regulatory duties are imposed on items bearing the highest rate of customs duty of 25 percent. In addition, advance trade VAT (ATV) is raised in FY10 to 2.5 percent from existing 1.5 percent on import of commercial goods. The wider application of supplementary duty and the introduction of regulatory duty of 5 percent on all items bearing the highest customs duty of 25 percent (which include mainly final consumer goods) have contributed to significant increase in tariff escalation with movement along the stages of production. That, in effect, has raised effective protection to import substitutes and increased dispersion in FY10 to 134 percent from 127 percent in FY09. The scaling up of tariffs to somewhat prohibitive levels on a number of final consumer goods may not only deprive benefits to Bangladeshi consumers but may also adversely affect revenue generation. Beneficiaries of Protection FY10 budget offers generous protection to a number of import-substituting industries that have consistently enjoyed very high rates of protection (more than 70 percent nominal rate of protection): domestic producers of footwear, ceramic tiles, tableware, sanitary ware and other ceramic items by raising supplementary duty from existing 20 percent to 45 percent on all such imports; domestic producers of particle board, hard board, medium density fibre board, plywood, leather goods, such as bag, suitcase, vanity bag etc., mosquito coil, imitation jewelry and corrugated cartons by imposing 20 percent supplementary duty on all such imports; domestic producers of toothbrush by imposing 45 percent supplementary duty on imported tooth brush; domestic biscuit factories by imposing 100 percent supplementary duty in place of existing 60 percent on all bakery, biscuit and confectionary imports; and domestic dextrose producing plants by imposing 20 percent supplementary duty on similar imports. The increase in the nominal rate of protection for many import-substituting industries is a concern. The approach in this budget (at least on the trade front) thus caters to a part of the domestic production lobby, rather than creating an environment for helping efficient exporters and providing consumers with access to better quality and prices of goods. Moreover, the benefit of protection will most likely be shared unevenly among the business companies big ones in particular. VII. Strategic Vision and Structural Reforms PRSP and Five Year Plan The Budget Speech brings clarity on the status of Poverty Reduction Strategy vis-à-vis the Five-Year Plan. It says we have reviewed the already prepared 3-year term PRSP (Moving Ahead ) in the light of our development philosophy and socioeconomic goals. We plan to complete this task within the next two months. On Five Year Plan it says Alongside this, we have begun our work on Five-Year Plan for This planning document will not be a traditional one with sectoral allocations, lists 14

15 of projects and investment plan. It will project goals and targets, explore alternative strategies for reaching the goals and targets. It goes on to say the current PRSP shall remain in force until 2011 and this document will be reviewed each year in normal course. Unified Budget from Next Fiscal Year Reforms in budget preparation and execution will be implemented from the next fiscal year. The national budget will be unified to help achieve the strategic objectives of the government in the short and medium term. The budget allocation will be classified as capital expenditure and recurrent expenditure at the disaggregated level. A way to manage this will be determined soon in consultation with the Planning Commission. The role of Government in Trade and Industry The Budget Speech commits the government to play the role of a close observer in the area of trade and industry and it would come forward only to tackle crises: Private sector promotion is our motto. However, the government is not contemplating divestment of any SOE in FY10, in light of the uncertain environment, and it made it clear that no SOE will be closed until alternative arrangements are made for the displaced workers. Financial Sector Major financial sector policies include: (i) (ii) (iii) (iv) Disbursement of loans to the private sector using risk-based assessment instead of collateralbased financing. However, there is no guidance on the issue of capacity building of the financial institutions to do this; Continuing automation of the Central Bank business processes. Apart from improving efficiency in central bank s operation this will help prevent concentration of credit to any individual or group and is expected to improve loan default situation; A 5-year strategic business plan has been prepared for the state-owned corporatized banks (SCBs) to improve quality of banking operation. It is not clear whether this has been done following the ongoing corporatization framework, and; A plan to form a new wholly-government-owned investment company through a merger of BSB and BSRS. Unless there is a qualitative change brought in the management and decision-making process of the new DFI, this will be another case of the same wine in a different bottle. Good Governance The budget speech lists the following measures taken by the government to improve governance: All the parliamentary committees were set up in the first session of the new parliament and these committees have started functioning; The first session of the parliament enacted 32 ordinances promulgated by the caretaker government, including the Right to Information Act, the Anti-Terrorism Act, and the Anti-Money Laundering Act; 15

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